The accounting value or "book value" of your company's assets -- or even the company itself -- probably differs from the market value, and the difference may be significant. The distinction between the two comes down to orientation. Accounting values are backward looking, while market values are oriented toward the present and future.

Conservatism

One of the fundamental principles behind financial accounting for businesses is conservatism. Simply put, conservatism means a business never wants to overstate good things, such as the value of its assets or the amount of its revenue and profit, and it never wants to understate bad things, such as its expenses or the the extent of its liabilities. When it comes to assets, accounting conservatism requires that they be listed on the balance sheet with a value that can be objectively determined.

Accounting Value

In most cases, the accounting value of an asset is the price the company paid to acquire it, referred to as "historical cost." That price is verifiable and objective -- the sale is proof of value -- so using it conforms to conservatism. As an asset ages, it gets depreciated, so its book value declines. At any point, the asset might well be worth more than its accounting value, but the only way to be absolutely sure is to sell the asset. Some incredibly valuable assets can't go on the balance sheet at all because there is no way to satisfy conservatism's demand for objective value. Brand names, trademarks, reputation and similar "intangibles" have no accounting value to the company that generated them. Only after an intangible has been sold can it be given an accounting value.

Market Value

Accounting standards define the market value of an asset as whatever you can sell it for in an "arm's length transaction," meaning a sale involving unrelated parties who go into the deal willingly. The problem with trying to list assets at current market value on the balance sheet is that you can't know what that value really is until you make the sale. If accounting rules allowed companies to list assets at what they "think" they'd get in a sale, there would be nothing to stop firms from vastly inflating asset values. Just about the only asset that a company can list on its balance sheet at market value is a tradable security, such as a stock, bond or commodity option. The objective value of most securities can be determined easily -- just check the current stock price -- so it's not a violation of conservatism to list them at market value.

Firm Value

Because assets must be listed at accounting value rather than market value, the book value of your firm -- the sum of your assets minus all your liabilities, according to the balance sheet -- is probably less than what you could actually sell the company for. Accounting value may well be dwarfed by market value. If you're trying to put a price tag on your business, book value is merely a place to start. You have to determine what the stuff on your balance sheet is really worth and put a value on the stuff that's not on your balance sheet.